Boom or Bust: What’s the Outlook For the Energy Sector in 2015?

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It appears that crude oil prices are starting to stabilize. At least, they’ve started to decline slower. Most of the “experts” who send price forecasts have the low being set in the $45 to $55 range.

This week we will see the first major winter storm of the season, which should draw more attention to the energy sector. The first “clipper” of the season will bring heavy snow, high winds, and very cold temperatures to an area of the country that burns a lot of natural gas for residential space heating. People in the Northeast still use a lot of heating oil to heat their homes, so this may have some impact on oil demand.

Outlook for 2015

2008 was the last time we saw crude oil prices plunge to anything like they have this year. That year the entire economy went into the tank, which in turn reduced energy demand. This year, it is the slowdown in Asian economies that is responsible for the International Energy Agency’s cut in its global oil demand forecast. Note that the IEA is still forecasting a significant year-over-year increase in demand.

If what happens next is anything like what happened after 2008, energy sector investors are in for a couple of very good years. 2009 and 2010 were two of the best years for the sector. Anyone who spread their money evenly over a group of high-quality upstream companies, drillers, and oilfield service firms on January 1, 2009, and rebalanced it quarterly should have doubled their money in two years.

At today’s oil and natural gas prices, the first half of 2015 will be rough sledding for most of the E&P companies, the drillers and oilfield services firms like Halliburton (NYSE:HAL) and Schlumberger (NYSE:SLB). There will be significantly reduced upstream capital programs this year, and 30% to 40% of the onshore rigs actively drilling during the fourth quarter of 2014 will be sitting idle in the yard by June 2015. Many oilfield workers will be filing for unemployment benefits during the months ahead. The rig count is already dropping.

As I wrote last week, what’s going on today is planting the seeds for the next energy crisis.

My focus is on finding small and mid-cap upstream companies that have strong production and proven reserve growth locked in while making sure they have plenty of liquidity to fund their growth. Take a hard look at their hedging program before you invest also. Two small-cap E&P companies that look well-positioned to survive the first half of 2015 and thrive during the second half are Diamondback Energy (NASDAQ:FANG) and Carrizo Oil & Gas (NASDAQ:CRZO).

Commodity prices are set by marginal supply and demand. Today the oil market is oversupplied by approximately 1.5 million barrels per day, primarily due to weaker demand in Asia and Saudi Arabia’s unwillingness to cut production. That may sound like a lot of excess supply, but we live in a world that consumes more than 93 million barrels of liquid hydrocarbon-based products each day, and demand goes up by about a million barrels year-after-year.

One reason to be bullish about oil and gas prices is that the prices for commodities, especially those which are vital to our standard of living, tend to revert to the mean after a very bad year.

Much of the world’s oil supply comes from countries that are far from stable places to do business. It took nine days to put out fires at one of Libya’s main oil terminals. The fires were set by a rocket fired on December 25 by Fajr Libya (“Libya Dawn”), a coalition of Islamist-backed fighters. The first fire quickly spread to six other tanks at Al-Sidra oil terminal.

Estimates are that Libya’s oil production dropped to less than 350,000 barrels per day from 800,000 previously since clashes around the export terminals erupted on December 13.

Fighters from Fajr Libya, which controls much of Tripoli, as well as second and third cities Benghazi and Misrata, have been trying to seize Al-Sidra and Ras Lanuf terminals.

On January 3, Reuters reported that forces loyal to Libya’s internationally recognized government staged air strikes on the commercial port of Misrata, a western city allied to a group that holds the capital, Tripoli. Fighting was also reported near the country’s biggest oil export port located in the east, part of a struggle between troops loyal to two competing governments and parliaments.

The point is that supply disruptions are common, and it is not entirely up to the United States to get oil supply and demand back in balance. Today’s low oil prices are reducing drilling everywhere, and much of the global supply can be cut off by terrorists.

I track more than 80 U.S. based upstream companies closely. Based on my analysis, U.S. oil production is going to continue to grow in the first half of 2015, but the pace of growth will slow. What I’ve seen is that many companies will exhaust their backlog of wells waiting on completions within a couple of months. I am expecting U.S. production to peak near the end of the second quarter. That just happens to be when the next OPEC meeting is scheduled.

In a note to clients on January 2, energy sector analysts at Sterne Agee said, “We believe the current oversupply in the global crude oil markets will persist until signs of U.S. production decreases become evident, which is unlikely to occur before mid-2015.”

It is important to remember that the markets look forward

As the E&P companies come out with their sharply reduced 2015 capital programs and production guidance (already happening), it will become very clear that U.S. production will be peaking in the second quarter this year. Also, harsh winter weather can impact well completion schedules. This is already happening in North Dakota’s Williston Basin.

Crude oil is the world’s most important commodity

It is vital to our standard of living, and there are no easy substitutes for it. Every oil well on this planet is depleting. In fact, average horizontal shale wells produce approximately 70% of the oil they will ever produce during the first two years after they are completed. Therefore, the price of oil cannot remain below the finding and development costs for new supply for long.

Conclusion

2015 is going to be an interesting year for energy sector investors. If you have a lot of energy sector stocks in your portfolio, hang tough. We are much closer to the bottom than the top. The industry has survived much worse cycles, and good management teams know how to survive until oil and gas prices move higher. Plus, Saudi Arabia is going to get a lot of heat at the next OPEC meeting in June if it doesn’t have a plan to firm up oil prices. I think we may see an emergency meeting of OPEC members much sooner.

Originally written for OilPrice.com, a website that focuses on news and analysis on the topics of alternative energy, geopolitics, and oil and gas. OilPrice.com is written for an educated audience that includes investors, fund managers, resource bankers, traders, and energy market professionals around the world.